What to Look for When Investing in a Business

Especially for first-time investors, it can be a scary plunge to start investing your money in other business endeavors. It could pay off big for you, but there is also always the risk of losing everything you put in. While it’s never a guarantee, the more research you put into the company before investing can help mitigate your risks. Here are five critical areas to investigate when you are considering investing your money in a company.

Management Team

Having a solid and experienced management team in place can make or break a company. Especially look at the CEO or President. Most growth funders want to see a management team that is cohesive with a strong (not arrogant) CEO at the helm. Look for a team that has worked together on other projects or has been together for a long time. Keep a wary eye out for backbiting or strife between team members. You’re looking for a team that can put aside their egos and work together to achieve the common goal of making the company successful.

This may sound cheesy but look for a CEO that you can connect with. This usually means at least a phone or teleconference with the CEO or perhaps an in-person meeting. Generally speaking, investing in a company means you are becoming a business partner (if you are getting stock in exchange for your investment) so it is essential that you know you can communicate and have some of the same values and vision.

Market Opportunities

No matter how fantastic the idea, if the market isn’t big enough you probably won’t get a significant return on your investment. The market for the product or service needs to be big enough for the company to have substantial room to grow. Usually, this means the company has national or even international potential. Ask questions and research the opportunity for market growth. Understand who the competitors are in the current market and what it is going to take to increase market share.

Growth and Risk

Alongside considering where a company can grow in the future, it is also vital to make sure the infrastructure is there for the future growth. It can be very risky to grow too quickly without the right foundation in place. Ask questions to understand how well the management team has considered the growth potential and the steps needed to mitigate the risk of growing too quickly. Look to make sure the team has thought through and set the right pieces in place to support rapid growth.

Exit Strategy

It is critical to know what the management team sees as the exit strategy for the company. Will it go public? Or is the goal to be acquired? You want to know what the time frame is going to be and decide if that is going to work for you. Some industries are more prone to certain types of exit strategies. For example, mergers and acquisitions (M&A) are more common in the consumer industries as opposed to tech industries where going public is more the norm.

Financial Performance

Of course, no list would be complete without the financial piece. It is essential to take a look at the following components of any company you are considering investing in.

Of course, no list would be complete without the financial piece. It is essential to take a look at the following components of any company you are considering investing in.

Revenue: Look for a revenue line that is trending upward over the last few years or at least holding steady.

Net Income: Growth in net income from year to year is important. It shows how to make adjustments as needed to keep their bottom line growing.

Profit Margins: Again, look for steady growth, which indicates that a company can manage its operating costs and reward shareholders with returns.

These are not an exhaustive list of what an investor should be watching for when investing in a company, but we hope it is enough to get you thinking. Investing is an exciting yet high-risk endeavor so the more prepared and knowledgeable you are the better your chance of investing in a company could pay off.

Top Questions Investors Ask Part 4

“People who ask confidently get more than those who are hesitant and uncertain. When you've figured out what you want to ask for, do it with certainty, boldness and confidence. Don't be shy or feel intimidated by the experience. You may face some unexpected criticism, but be prepared for it with confidence.” Jack Canfield

Being prepared can help you answer investors’ questions with confidence and certainty. This is the last in our four-part series of common questions investors can ask. While this is not an exhaustive list, we hope that it will help you be better prepared to ask for what you want with confidence. Today we will cover intellectual property, financials, and your financing round.

Your Intellectual Property, Patents or Trademarks

The intellectual property (IP) of your business can include trademarks, patents, copyrighted designs, and confidential information. Your company’s IP is extremely valuable; they can set your business apart from competitors, be used as security for loans, provide a revenue stream if sold or licensed, and can be an essential part of your branding and marketing. Here are some of the questions you may get about your company’s IP.
• What key IP does your company have?
• How was your company’s IP developed?
• Can the IP be liquidated?
• Are you looking at infringing on the IP of another company?
• Would acquiring IP from another company add value to your company?
• What proof or confidence you have that your company’s IP does not violate the rates of a third party?
• Is it possible that any prior employers of a team member have a potential claim your IP?

Your Company’s Financials

When you get to this stage, be prepared to walk an investor through your financials including your profit & loss statement, balance sheet, and financial model. It isn’t uncommon for an investor to request a special session for the financials and bring an analyst with them. Here are some questions you might get asked.

Which key metrics does your leadership or management team focus on?

Are there factors that have been or will limit faster growth?

How much burn do you expect to happen until the company achieves profitability?

Are you setting aside a stock option pool for employees?

What is the capitalization structure? How much equity and debt has the company raised?

What are the company’s three and five-year projections?

What key assumptions lead you to your projections?

When do you expect the company to be profitable?

Your Financing Round

This group of questions helps the investors get a better idea of who the other players are. They want to know how much money has already been raised (if any) and where it came from. Knowing what the equity structure looks like is usually a key component.

What will the proceeds from this round go to?

Are there existing investors and will they participate in this round?

Which round of funding is this?

How much funding are you looking to raise in this round?

Who holds equity and how much do they hold?

Have you done crowdfunding before?

Has anyone else invested in this round?

Has an accelerator or incubator already committed funds?

Does your company have any convertible loan notes?

What is your company’s desired pre-money valuation?

While it’s natural to be a bit nervous when pitching new investors, the best thing you can do is to be as prepared as possible. While our series is not an exhaustive list of possible questions, it can be an effective tool. Making sure you have answers to the questions in our series is a great place to start. We even recommend you take some time and practice answering the questions. As Jack Canfield says so well; prepare, prepare, prepare so you can ask for what you want with boldness and confidence.

The term “angel investor” has grown in popularity in recent years, even to the point of becoming trendy. But what does it mean to be an angel investor and is that what you really want to do?

Definition of an Angel Investor
An angel investor invests his or her own money in a business, usually in exchange for an ownership percentage (i.e., equity) of the company. Contrast this with venture capitalists who invest other people’s money. Interestingly enough, the term comes from the world of Broadway theater when an “angel” would donate money to specific productions. The term we use today was coined by William Wetzel, founder of the Center for Ventrue Research at the University of New Hampshire.

In recent years a combination of factors has to lead to a rise in the number of angel investors. First, many individuals are looking for alternative and more lucrative avenues for investment than the traditional stock market. Second, as banks continue to be tight on giving bad credit loans and even general business loans, the need has increased for alternative business funding. Third, technology gives individuals the opportunity to connect across distances on a level that has never been seen before. Fourth, equity investment and angel groups allow people with smaller amounts of funds to invest to be a part of funding companies.

Do I have to be a Billionaire to be an Angel Investor?
It is a common misconception that you need to be a millionaire or billionaire to invest. If you are a family member or friend and you invest $60,000, for example, in a start-up, you are an angel investor. Typically, an angel investor is someone who has “extra” cash they can invest that if lost, it would not affect their day to day standard of life.

In attempts to protect investors from being taken advantage of, the U.S. Securities and Exchange Commission (SEC) has set up certain restrictions for non-accredited investors and requirements to become an accredited investor. The following are the two most generally used SEC standards of an accredited investor:

Outside of your primary residence, you must have a net worth more than $1 million, either alone or together with a spouse; or

You must have an annual income that is more than $200,000 or $300,000 if filing jointly with your spouse. You must be able to show that you have maintained the annual income for two years and that there is a reasonable expectation that you will make that money in the current year.

What are the Risks of Being an Angel Investor?

As with any investment, there are risks involved. If the company you invest in does not make it and must close its doors, you will probably lose the money you invested. This is the case for anyone anytime they invest funds. Therefore, it is wise to not invest if you can’t afford to lose 100% of that investment.

Another potential risk has to do with what happens to your shares after you purchase them. If you do not secure preemptive rights (also known as anti-dilution provisions, or subscription rights), the initial buy-in can get diluted so much that your investment may lose its value. When a company needs to do their next level of fundraising, they will generally “dilute” the shares by selling more. This common and completely legal practice means everyone has a smaller slice of the pie and the shares they do own are worth less than they originally were. For example, let’s say you invested in a company and received 1 of the 100 shares. Dilution would happen if the company sold another 100 shares of the company, now your share is worth 0.5%. If you have preemptive rights, before the 100 shares go up for public sale, you have to option to buy enough to maintain your 10% ownership. You are not obligated to buy them, but you do have the option.

While being an angel investor comes with risks, you have more options available to you than ever before. It is easier to connect with entrepreneurs or products you are interested in. Additionally, equity investing groups or angel investment groups make it easier to connect and spread some of the risks.

A convertible note (also referred to as convertible debt) is a debt loan that converts to equity when a company reaches a certain milestone, usually the next round of equity financing. It is a common way for early-stage startups to fundraise.

Convertible notes are commonly used as it is less expensive for a company to fundraise using this method as legal costs for document creation are lower which is useful for smaller rounds of funding at earlier stages (before Series A).

We believe investing in early-stage startups is very different than investing in public market opportunities. Besides the unique opportunities associated with startup investing, and the long term liquidation nature of your investments, startups use slightly different terminology with which you may not be familiar. Below is a sample of the most commonly used deal terms.

In a previous post, we delved into the importance of diversification in a start-up portfolio. We looked at ‘The Babe Ruth Effect’ and the number of different positions that should be taken to properly diversify an early stage investment portfolio. Startup investors must be aware that they are going to encounter more losses than wins. Success of a portfolio is based on those few home runs, which drive the overall return. However, there is a degree of nuance and some pitfalls that are worth noting in order to diversify successfully.

Diversification is key to mitigating risk and maintaining a healthy startup portfolio. As media coverage is saturated with news of unicorns like Facebook and Alibaba leading to huge paydays for investors, it’s easy to look past the risk to the possible reward. But it’s important to remember that the majority of startups fail. According to performance analysis by the Kauffman Foundation, 52% of all venture exits are at a loss. How can you integrate diversification into your portfolio?